Halfords has a dividend yield of 5% at its current share price of 342p.
That’s an attractive yield for a somewhat defensive retailer, but in recent years its go-faster stripes (or at least its previously high growth rates) have fallen off.
So is Halfords a future dividend champion or dividend trap?
I think it’s more likely to be the former, and here’s why:
A mature retailer with a dominant market position
Halfords is far and away the UK’s number one retailer of car maintenance products (e.g. wiper blades, bulbs and batteries) and car enhancement products (e.g. big chrome exhaust pipes, dash-cams and in-car connectivity equipment).
Car products make up about 70% of its retail business, with the other 30% coming from selling bicycles and bike parts, accessories and clothing.
As is typical of large national retailers, Halfords’ retail business operates mostly through out-of-town superstores.
The other side of its business is car service and repair, carried out through a national network of several hundred garages which were acquired in 2010 as part of Nationwide Autocentres.
A somewhat bumpy track record of growth
Here’s a snapshot of Halfords’ somewhat up and down progress in recent years:
As you can see, revenues have been going up fairly steadily while profits and dividends have been through a boom, bust and recovery cycle.
Looking at Halfords from a different angle, here are a few of the company’s key metrics relative to the FTSE 100 (you can find out more about these metrics in these articles or these spreadsheets):
- 10-Year growth rate = 0.3% (FTSE 100 = 2.2%)
- 10-Year growth quality = 63% (FTSE 100 = 50%)
- 10-Year profitability (ROCE) = 15% (FTSE 100 = 10%)
- Total borrowings/five-year avg. profits = 1.0 (FTSE 100 avg. = 4.0)
- Defined benefit pension liabilities = zero (no DB scheme)
Those metrics tell the following story:
- Halfords overall growth was very slowly thanks to a decline in profits and dividends in the middle of the period (revenue growth was better at 3.4% per year)
- Although slow, its growth has been more consistent (i.e. higher quality) than the market average
- It has good profitability, low debts and no pension liabilities, which are all positive signs as far as I’m concerned
One interesting point is that Halfords managed to do very well during the financial crisis of 2008-2010.
To some extent that was the result of deferred car purchases; people spending money servicing and doing up their existing cars rather than upgrading to a new car.
To a smaller extent Halfords’ profits increased thanks to its acquisition of Nationwide Autocentres in 2010, which added hundreds of car service and repair garages to the Halfords brand and millions of pounds of profit.
But as often happens during a boom – and especially during an unexpected boom – management’s optimism went through the roof.
In 2010, in the middle of the financial crisis, the dividend was increased by 26%. Even more surprising was that year’s annual report, which mentioned a new acquisition-fuelled growth strategy expected to deliver sustainable growth of 15% per year.
Personally I find it hard to believe the directors were so optimistic. With the benefit of hindsight, targeting a 15% growth rate appears to be borderline delusional (at that rate Halfords would double in size every five years).
Despite the incredulity of this target, the dividend was increased again in 2011, this time by 10%, but after that the music stopped and from 2012 to 2014 Halfords’ growth went into reverse.
In simple terms, the sluggish UK economy eventually caught up with Halfords, as it had so many other retailers. Profits fell and in 2012 and 2013 the dividend was cut.
However, I think this early dividend cut was a positive sign.
Decisive action by management produces a rapid turnaround
Rather than burying their heads in the sand and sticking to an arbitrary dividend policy no matter what (as many companies do), management did the sensible thing and cut the dividend early, which allowed them to re-think where that cash could most profitably be directed.
After a period of review, the answer that came back in 2013 was that far more cash should be reinvested back into the company’s core retail business.
Why? Because during the period from 2009 to 2013, investment in capital assets such as stores, warehouses, IT systems and so on, was not enough to keep up with the depreciation of the company’s existing capital assets.
As a consequence, things that were wearing down and becoming outdated (like the in-store environment) and were not being fully replaced, let alone upgraded and expanded as should be the case for a company targeting any sort of growth, let alone growth of 15% per year.
As far as I can tell, cash which should have been reinvested into the cash-generating retail business was instead seen as fuel for dividend growth, share buy-backs and acquisitions. There is an important lesson here:
If you fail to feed the golden goose, it dies (or at least it gets sick and stops laying so many golden eggs).
So in 2013 a new strategy was born which would involve far higher levels of capital investment in order to improve the stores, the website and other infrastructure, as well as introduce a Halfords loyalty card in order to capture information about the lifetime value of each customer (which Tesco has been doing for 20 years).
Over the last three years capex has almost doubled compared to the period of underinvestment, and it’s set to be at that higher level for at least the next three years as well.
Here’s what that period of underinvestment and recovery investment looks like:
This is a good counter example for investors who like to focus on free cash flow.
Yes, having lots of free cash flow is good, but not if that free cash flow means the core business is starved of cash.
That’s why, as part of my capital cycle analysis, I like to look at the capex to depreciation ratio, because depreciation can be used as a crude estimate of maintenance capex. If capex is consistently below depreciation then underinvestment is a real risk.
So in the last few years Halfords has been through an unexpected boom, followed by a decline that to some extent may have been driven by underinvestment, followed by a swift dividend cut and much higher levels of investment in the core business.
Halfords seems to be turning around, but what about its longer-term future?
Slow growth for the company, but Halfords’ investors could do better
Halfords has been around since the end of the 19th century and I expect it to be around for many more years to come (or at least until we all start travelling around in Uber/Google self-driving transportation pods).
However, it is a very mature business with more than 400 stores in the UK and I think it would be hard to double that number, let alone triple it, so high rates of future growth are unlikely.
The company’s own analysis shows that the car market is growing at less than 3% a year while the bike market is growing at less than 8%. With its current 70/30 split of car/bike revenues, perhaps growth in the region of 5% a year is an optimistic but realistic target (far more realistic than 15%).
Of course the company could try to expand overseas, but it has already tried that several times in the past and failed, and has no plans for international expansion in the near-term.
So with its current dividend yield of 5% and an optimistic future growth rate potential of 5% a year, I think Halfords could be a good long-term investment, with a possible yield-plus-growth total return of around 10% a year.
That’s a pretty good rate of return, but not anything to get excited about.
However, with a bit of luck investors could achieve a much higher rate of return.
That’s because Halfords is a retailer and retailers are usually cyclical (although as retailers go, Halfords is somewhat defensive because a significant part of its business is the sale of non-discretionary MOT-related products and services).
Cyclical retailers go through booms and busts and investors have a tendency to over-extrapolate both, driving the share price to excessive and sometimes ludicrous highs and lows.
In this case, Halfords share price has broken through the 500p barrier twice in the last few years; first, in 2010, when everything was going well, and then in 2015, when the company’s profits and dividends increased for the first time in several years.
Following both highs the share price subsequently collapsed when reality failed to justify the lofty price, and at one point in 2012 the share price fell below 200p.
With a price of 342p as I write, I think there is a reasonable chance that sensible investors can benefit once again from the irrational exuberance of other investors.
If at some point in the next few years things start to go even slightly better than expected for Halfords, I think there’s a real chance a share price of 500p or more could be on the cards again.
If that were the case, and if I were a shareholder at the time, I would almost certainly sell in order to lock in those outsize capital gains.
But whether or not that actually happens is another matter.
Target buy and sell prices for Halfords
With the shares at 342p Halfords currently has a rank of 61 out of 225 dividend-paying stocks on the UK Value Investor stock screen. This is slightly outside the top 50, which is where I usually restrict my purchases to.
So although I think Halfords is probably good value at its current price, it’s not quite in my buy-zone yet.
For me to invest the price would have to drop below 300p, giving the shares a yield of 5.7%.
That may seem like a bit of a stretch, but you only have to look at Next (which is a holding in the UKVI model portfolio) to see how far a well-established retailer’s shares can fall in a very short space of time.
As for a target sell price, for me that’s what I call the “fair value” price, which occurs when a company sits at the halfway point on the UKVI stock screen.
For Halfords that would require a share price of 550p, which is about the same as the maximum value reached during the 2010 and 2015 peaks.
At that price it would have a dividend yield of 3.1%, assuming its current dividend was maintained rather than grown, and I think that’s a reasonable yield for a company with a potential growth rate of 5% per year.
Of course I’m not after a reasonable yield; I want an unreasonably good yield, so if Halfords did reach 550p in the next few years I’m pretty sure I would have sold out before then.
John Spencer says
Do you understand why/how a company like Halfords can have £358 millions of Intangible Assets sitting on it balance sheet?
I tend to discount Intangible Assets when looking a business and this £358 sticks out like a sore thumb on what otherwise is pretty clean balance sheet.
John Kingham says
Hi John, it’s mostly goodwill from when Halfords was bought from Boots in 2002.
CVC Partners, a private equity firm, bought Halfords for £427m:
The new Halfords Group company was saddled with the debt and the goodwill, which came to £253m.
The debt was paid down using cash from the IPO, but the goodwill remains. It’s supposed to be amortised over 20 years, but it doesn’t seem to have gone down very much so far.
There is also another £70m of goodwill from the Nationwide Autocentres acquisition in 2010 and £10m from the acquisition of Boardman Bikes.
John Spencer says
Goodwill always struck me as a place for management to bury their mistakes. I would expect to the goodwill slowly vaporize over the years also so it is odd not to see it fall even a little bit.
I always enjoy reading your pieces and enjoyed hearing you on Dividend Health Checkup.
Thanks John for your reply
John Kingham says
No problem John. The original plan, according to the 2004 annual report, was to amortise it over 20 years, but perhaps they changed that plan somewhere along the way, either for a longer period of amortisation or to use annual adjustments/impairments instead, although I haven’t checked.
I wanted to ask a more general question about the defensive value portfolio. In the event of a market correction how would the overall dividend yield be expected to perform? Would you expect dividends to be cut significantly or would they be maintained?
John Kingham says
That’s a good question, but difficult to answer with any certainty.
My guess (and that’s all it is) is that a correction wouldn’t necessarily affect the dividend as a correction is primarily a move in market prices rather than corporate fundamentals. However, a bear market is likely to be driven by fundamentals and so a dividend decline would be a real possibility.
However, with a well-diversified portfolio I wouldn’t expect to see much of a decline in the total dividend, perhaps 10% or so at most. I think much more than that would require something bordering on a depression.
But the truth is that I would need to see the portfolio go through a bear market or two before I could be more certain.
Also, a more general point is that I would expect any dividend decline to be smaller than those of the FTSE All-Share, as having lower risk and a higher yield than that index is a central goal of the portfolio.
Walter @ Walbrock Research says
I see Halfords isn’t immune to the tough retail environment. Also, management didn’t think the weak pound will have an effect of its guidance.
Do you think Halfords profits will under pressure, despite management confidence about mitigating adverse FX?
With Halfords, are you not neglecting capital appreciation and diversification in your portfolio?
Also, I notice businesses with superior earnings with a lack of cash in the bank tends to have volatile share price. And like NEXT PLC, the shares get crushed when earnings start to dip.
John Kingham says
Hi Walter, it’s a tough environment for retailers what with Brexit, Sterling depreciation and the Living Wage (I think the Living Wage is a good thing but it’s still a headwind).
Regarding capital appreciation and diversification, I’m not sure what you mean. I definitely think Halfords could appreciate nicely, given its previous highs of over 500p, and in terms of diversification, that’s specific to each investor so I didn’t bother to mention it. In terms of the UKVI model portfolio it’s already maxed out on General Retailers (it holds three, which is my limit from any one sector), so yes, Halfords won’t be joining the model portfolio unless one of the existing retail holdings is sold.
As for your last point, I think that’s probably about right. I guess the market is more jittery about companies that don’t have a reasonable cash buffer, and rightly so!
Walter @ Walbrock Research says
For me, General Retailers is a board sector where you get companies selling clothes, online retailers, birthday card sellers, car dealerships, wine sellers, antiques etc. So, I would classified Halfords in the vehicle services category, which is different from the rest.
Oh, about the living wage, there are advantages and disadvantages like everything else, but what do you think of Jeremy Corbyn wage/salary cap?
I mean if there was one world one country it could work, but since there are over 150 countries (don’t quote me on that) would the successful and smart people leave the country. Just look at happening to Venezuela!
John Kingham says
I don’t see how a salary cap can work. I prefer progressive taxation of one sort or another.
As we know..the retail sector is tough because of brexit and it’s uncertainty but markets have been placed in a boom for years now..being helped by low interest rates and consumer sppending. Do you expect a stock market decline??
John Kingham says
Hi James, although the UK markets (FTSE 100 and 250 specifically) have generally done quite well, I don’t think they’re overvalued and I don’t particularly “expect” to see a market decline. But of course the market can do what it likes, so there could well be a bear market if Brexit goes badly, or for any one of a million other reasons.
I agree that retail is tough, which is why I own three UK retailers as they’re very out of favour at the moment. Hopefully that will change one day and the shares will go up as investors become more optimistic.
I didn’t know you replied to my question last month. I thought maybe I would get email alert or something. I only came back to your website by some email that you reviewed some book. Anyways, it’s a very nice website you have here with some good information. I don’t see why you think stocks aren’t overvalued. If you check the FTSE 250 index, it’s like near new highs, more high than it was before the last recession, I believe. However, there are some stocks that are going lower, maybe reacting to brexit perhaps..and also other stuff. Yup retail is tough, in shops, as so many sell stuff online now. If you haven’t already,…. care to share which retail stocks you have invested in?
John Kingham says
Hi James, thanks. An index or a company isn’t expensive because it’s at record highs, it’s expensive because it’s at high multiples relative to earnings and dividends. In the case of the FTSE 250, I think it is slightly expensive, but only slightly. The FTSE 250 price is currently about 26-times its inflation adjusted ten-year average earnings (otherwise known as CAPE, the cyclically adjusted PE ratio) which is slightly above its long-term average of 20. So yes, I do think the FTSE 250 is slightly expensive, but the FTSE 100 is priced at an historically average level relative to earnings and dividends (its dividend yield is over 3%, so it’s unlikely to be expensive).
Neil Woodford has written recently about the impact of Brexit on UK-focused stocks:
I tend to agree with is positive assessment, so I do own some UK retailers. I won’t disclose all of my retail holdings, but one stock I hold is Next.
Thanks John, I will have a read of it. Is that a hedge fund?
I saw somewhere that the p.e ratio of Next is under 10. Is this so? Does that mean it is an undervalued stock and is that why you are holding onto that stock? Not a stock am interested in though.
John Kingham says
Is Woodford Funds a hedge fund? No, it’s one of the most popular and famous retail fund managers in the UK.
You can find Next’s PE on lots of websites such as:
A PE of less than 10 is low but it doesn’t mean the shares are cheap and that isn’t why I own the stock. There is much more to stock picking than looking at a single ratio! Personally I prefer the PE10 ratio, which is the ratio of price to 10yr average earnings. But even that’s just one ratio and I probably look at more than ten ratios in total.